Bank Insurance Fund Reserve Ratio Above Statutory Minimum - For Now

The Federal Deposit Insurance Corporation reported today in the Quarterly
Banking Profile that the Bank Insurance Fund (BIF) reserve ratio rose
to 1.26 percent at the end of June, just slightly above the statutorily
mandated Designated Reserve Ratio (DRR) target of 1.25 percent. At March 31,
the BIF reserve ratio stood at 1.23 percent.1

The increase in the BIF reserve ratio in the second quarter resulted
from both an increase in the BIF balance and a decrease in BIF-insured
deposits. (The BIF reserve ratio is determined by dividing the BIF balance
by the estimated amount of deposits insured by the BIF.) The BIF balance
grew by 1.6 percent ($490 million) during the second quarter of 2002,
ending the quarter with a balance of $31.19 billion (unaudited). The
strong second quarter growth in the BIF, as compared to the first quarter
growth of $258 million, was primarily due to higher interest income from
investments and greater unrealized gains on securities. BIF-insured
deposits decreased by 0.1 percent during the second quarter.

The BIF reserve ratio figures significantly in setting BIF deposit
insurance premium rates. Under current law, if the BIF reserve ratio is
below 1.25 percent, the FDIC's Board of Directors must charge premiums that are
sufficient to restore the reserve ratio to the DRR within a year, or it
must charge premiums that average at least 23 basis points until the
reserve ratio meets the DRR. Currently, most institutions do not pay
premiums for deposit insurance.

When the FDIC's Board meets later this year to set deposit
insurance premium rates for the first half of 2003, the June 30, 2002, BIF
reserve ratio may be the most current available ratio. Estimated insured deposits are
calculated from Call Reports that are filed up to 45 days after the
end of each quarter. Editing the Call Reports and calculating
estimated insured deposits can take an additional two to three weeks.
Therefore, estimated insured deposits—and, hence, the reserve ratio—for
the end of September may not be finalized when the FDIC's Board meets.

The FDIC's Board will not be limited solely to
looking at the June BIF reserve ratio, however. Although the September 30
reserve ratio may not be final, the Board will have data available on the
factors that go into determining the reserve ratio. The September 30 BIF
balance will be available and the FDIC is working to enhance its estimates
of insured deposit growth.

Predicting how the reserve ratio will change from one quarter to the
next is difficult. The trend in the BIF reserve ratio over the past few
years has been downward (see Chart 1), but fluctuations in the reserve
ratio from quarter to quarter are not uncommon. These quarterly changes in
the reserve ratio have varied between -4.5 percent and 2.4 percent over
the past few years.

This volatility stems from fluctuations in the factors that determine
the reserve ratio. Estimated insured deposits, which by definition are
inversely related to the reserve ratio, are one of the major determinants
of the reserve ratio. BIF-insured deposits have generally been growing, but the level has been volatile
over the past few years. Growth rates of insured deposits have
varied between -0.5 percent and 3.4 percent per quarter. The volatility in
the growth rate of insured deposits has contributed to fluctuations in the
BIF reserve ratio (see Chart 2).

Fluctuations in the BIF balance can also lead to fluctuations in the
reserve ratio. Several factors determine changes in the BIF balance from
quarter to quarter, including changes in the contingent loss reserve—the
amount set aside to cover losses from probable failures; actual losses
resulting from insured institution failures when they are different from
the amounts set aside in the loss reserve; assessment income; interest
income; and changes in the value of Treasury securities in the BIF's
available-for-sale portfolio. On balance, these factors have interacted to
produce a fluctuating BIF balance over the past few years (see Chart 3).

Under current law, because the BIF ratio is near the DRR, even small
fluctuations in the reserve ratio can have financial consequences for BIF-insured
institutions. For example, large insured deposit growth during the third quarter
or losses from bank failures that exceed expectations could result in the
BIF ratio falling below 1.25 percent. In that event, the FDIC Board may
determine that premiums are necessary to maintain the target DRR.

To keep small fluctuations in the reserve ratio from greatly affecting
premiums, and to solve other problems with the current system, the FDIC
published Recommendations
for Deposit Insurance Reform in April 2001. Among other things, the
FDIC is seeking greater discretion from Congress to establish a range for
the reserve ratio and to set risk-based deposit insurance premium levels
to reflect actual risk in the industry and to the insurance funds. The House acted
on the FDIC’s recommendations by passing legislation, H.R.
3717, on May 22. Another reform bill, S.
1945, was introduced in the Senate earlier this year. Both bills would
grant the FDIC significantly greater discretion to set the DRR. H.R. 3717
would allow the FDIC to set the DRR between 1.15 and 1.40 percent; S. 1945
would allow the FDIC to set the DRR between 1.0 and 1.5 percent. Both
bills would allow the FDIC to determine the factors it considers important
when setting risk-based premium levels, and would end the hard-and-fast
rule that premiums for all institutions must increase when the reserve
ratio falls below 1.25 percent.

In the absence of new legislation, however, existing law combined with
the volatility of the BIF reserve ratio could force the FDIC to increase
premiums for BIF-insured institutions in the near future.

FDIC Chairman Donald Powell addresses the need for deposit insurance
reform and discusses the current adequacy of the BIF in a speech today
before the Fall Conference of the Financial Services Roundtable.